Why I'd fix for 3 years

The Auckland housing market has predictably heated up again this year off the back of strong immigration, low interest rates, and rampant speculation. The latter driven by the blind pursuit of capital growth.

So the Governor won’t be happy.

The dilemma he faces is that increasing interest rates is not an option. By the time this article is published we may have hit parity with the Australian dollar and Australia may have dropped interest rates again. They are currently 2.25% versus 3.50% in NZ. The NZ Reserve Bank needs to be able to influence the property market without needing to resort to higher interest rates. To do that means introducing more macro-prudential tools, which if successful, could provide the headroom for lower interest rates.

What are the implications?

The most obvious change that has already been mooted is a new class of mortgage for property investors. This would allow the Reserve Bank to be more targeted with its tools. Property investment loans are likely to attract more capital and therefore be priced at a slight premium to residential home loans. So pricing will not be so favourable in the future. This change is almost dead certain. The Reserve Bank could also limit the time a loan can be interest-only. Interest-only could become a hardship provision and be restricted over time to a small percentage of loans similar to the low LVR speed limit. This would significantly reduce the “cash flow” on properties. For example an Auckland $700,000 property (100% debt funded using equity in the home) and with a yield of 5.00% would go from -$830 per month to -$1,560 per month. It would also reduce the free cash flow available for investors looking to retire with passive income. Removal of interest-only would create a step change in how the property investment market behaves, and would have a disproportionate impact on Auckland where yields are lowest. The Reserve Bank could be subtler and tighten lender credit criteria. It would do this by “encouraging” lenders to increase the interest rate used to test servicing and the minimum surplus to cover living expenses. Some lenders are at 6.00% and others already as high as 7.75%. If all lenders were up around 7.50% then this would make it harder for investors wanting to leverage up further. Lastly the Reserve Bank could require loans to be serviced by NZ domiciled income. There would need to be an exception for overseas-based NZ citizens looking to come home. This policy would reduce the ability for non-residents to borrow in NZ, but also the ability for new residents to borrow based on often-fake overseas income verification. It would be a small easy change and one I’m keen to see. Although interest rates are likely to stay low for a long while yet (and some argue they could go lower) as an investor, I’d be encouraging you to fix long term now to lock in your cash flow. As I write SBS still has a 5-year rate at 4.99%, TSB has a 10-year fixed at 5.85%, and the major banks are still writing 5 year fixed loans at 5.50%-5.70%. My final advice would be to not get too greedy and chase rates over managing your risk. It would be foolish to lock everything in with a minnow bank (honeymoon rate) and limit your options later on.